The communications services sector is still relatively new since it was formed in late 2018. In that short time, though, the sector has seen a lot of movement. The sector’s constituents include some of the high-flying stocks of the past few years, like Facebook Inc. (NASDAQ: FB) and Netflix, Inc. (NASDAQ: NFLX), that have seen sharper pullbacks over the past several months.

Looking at Q3 2018 results, the sector did pretty well compared to the broader S&P 500 (SPX). Overall, the communications services sector delivered 31.8% year-over-year earnings growth and 19.4% revenue growth, according to FactSet. And based on their research, 77% of communications services beat earnings estimates, while 12% were in-line and 12% missed.

Where there were more concerns among analysts was top-line growth: Only 59% of the companies in the sector beat analyst expectations for revenue growth, whereas 42% of them missed. Weakening top-line growth from increased market saturation and global competition has been a common concern among many analysts and investors for the past several quarters. The upcoming earnings season could hold clues as to the extent the problem might persist.

For Q4 2018, the communications services sector is expected to deliver 20.1% year-over-year revenue growth, the highest out of all eleven sectors in the SPX, per FactSet. Earnings growth, on the other hand, is expected to lag a little bit and come in at 13.3%, the fourth highest out of eleven sectors, with the greatest growth coming from the diversified telecommunications services industry and the media industry.

One thing to note is that Alphabet Inc. (NASDAQ: GOOG) is expected to be the biggest driver of revenue growth, accounting for 8.1% of the total 20.1% expected growth—this is partially due to its two classes of shares, which elevates the revenue growth figures.

Communications Services and Weight. The chart above shows the S&P Communications Services ($IXC), compared to Facebook (FB, purple line), Alphabet (GOOGL, teal line) and Netflix (NFLX, red line) since the start of the fourth quarter. With only 26 constituents, those three companies alone typically account for about 40% of the whole sector. Chart source: thinkorswim® by TD Ameritrade. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

Valuations More Reasonable?

Since mid-2018, several of the stocks in the sector that had rallied substantially started to show weakness. FB and NFLX’s troubles started in July after the two delivered midyear results that failed to impress investors’ lofty expectations.

Sentiment seemed to shift rapidly for stocks that had been up substantially earlier in the year. FB ended 2018 down almost 28%, a ways from the all-time high of $218.62 that it hit in July 2018. GOOGL also ended the year in the red, down 2.7%. NFLX posted a 33% gain, handily outperforming the market but well short of the more than 100% increase the stock had halfway through the year.

There seems to be one camp of analysts that thinks the pullback provides a buying opportunity in tech companies that have consistently delivered double-digit revenue growth, while the other side seems to think the decline is warranted based on weakening expectations going forward.

Regardless, they “buy the dip” mentality doesn’t look to be in play this year.

Regulation Concerns at Home and Abroad?

Several of the companies in the communications services sector, such as Facebook Inc. (NASDAQ: FB), Twitter Inc. (NYSE: TWTR) and Alphabet Inc. (NASDAQ: GOOG), have been the focus of increased government scrutiny, particularly in the US and the EU.

Top executives from FB, TWTR and GOOGL all faced questioning by Congress in 2018 over a range of issues including privacy and data practices. FB had several data breaches, and concerns over how it was using customer data resulted in complaints being filed with the Federal Trade Commission.

Overseas, the EU slapped GOOGL with a $5 billion antitrust fine related to its Android operating system in mid-2018. The year prior, GOOGL was fined $2.7 billion by the EU for giving preferential treatment to its shopping service over competitors.

Outside of data and privacy, there are other regulatory concerns the sector has faced in China, particularly gaming stocks like Activision Blizzard Inc. (NASDAQ: ATVI) and Take-Two Interactive. China’s government started heavily cracking down on video games in 2018 and the country’s General Administration of Press and Publications will be responsible for implementing controls on its gaming industry.

This ongoing government scrutiny, whether in the US, EU or China, has resulted in company’s taking steps to address issues before they become too much of a government focus. It has been a common worry among analysts that these self-regulation steps could impact different businesses, either through reduced revenue or added costs from implementing solutions to address potential problems. And a wild-card risk has always been the possibility of unexpected regulation and/or fines.

Upcoming Earnings Dates

The companies below cover most of the major constituents of the communications services sector and when they’re scheduled to report earnings:

Throughout Q4 earnings season, make sure to follow Earnings Reports on the Ticker Tape for what might be expected from upcoming company reports. And keep an eye on the Daily Market Update for a rundown on what’s moving markets each day.

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